00:00:05
Fannie and Freddie have been around for
00:00:07
a very long time. They've operated as
00:00:10
private entities, shareholder entities
00:00:13
with an implicit guarantee but
00:00:15
specifically without an explicit
00:00:17
government guarantee so that they were
00:00:19
not in fact
00:00:21
federally owned organizations
00:00:24
or controlled organizations, but as of
00:00:27
September 8th, 2000 and 8 strike that,
00:00:31
as of September 7th, 2008
00:00:34
they
00:00:36
they came under government control. With
00:00:38
the crisis in the overall housing
00:00:40
market, with the demise of Lehman
00:00:43
it was clear that Fannie and Freddie
00:00:45
were illiquid, ill insolvent, and
00:00:48
required a government intervention to
00:00:51
prevent their meltdown, which of course
00:00:53
would have brought down the entire
00:00:54
housing market. At the time the housing
00:00:56
market was in freefall, but this would
00:00:59
have clearly without support of Fannie
00:01:01
and Freddie taken a great recession and
00:01:05
made it into great depression 2.0.
00:01:08
The intervention was necessary. At that
00:01:11
point, Fannie Freddie became regulated
00:01:13
entities and controlled by the Federal
00:01:16
Housing Finance Agency, FHFA
00:01:20
which is a separate independent entity,
00:01:22
and Fannie and Freddie are now under
00:01:25
conservatorship directed by FHFA.
00:01:32
Clearly keeping FHFA in the oversight
00:01:35
position forever with Fannie and Freddie
00:01:37
in a conservatorship what that means is
00:01:40
that the taxpayers on the line for all
00:01:42
losses, totally on the line for losses
00:01:45
in Fannie and Freddie. And this is not a
00:01:48
long-run viable solution.
00:01:51
Having basically a nationalized housing
00:01:53
finance system is not something that's
00:01:55
viable for the long run for the United
00:01:57
States.
00:01:58
So, alternatives are
00:02:01
must be considered and are being
00:02:02
considered.
00:02:04
But they range from one side of the
00:02:07
spectrum to the other side of spectrum,
00:02:09
and getting to consensus is been
00:02:11
problematic.
00:02:16
Well, there are and the dialogue has
00:02:20
evolved on this. And there are broad
00:02:23
areas of agreement, not perhaps 100% but
00:02:26
among many parties, again across the
00:02:29
political spectrum there has uh
00:02:32
agreement has come about on some very
00:02:35
important aspects of how to reform
00:02:37
Fannie and Freddie.
00:02:39
First, the need for a 30-year fixed-rate
00:02:41
mortgage going forward, that this is an
00:02:44
instrument that provides protections to
00:02:47
homeowners and that it there is a need
00:02:50
for this mortgage product in the United
00:02:52
States.
00:02:54
Uh
00:02:55
secondly, the need for a liquid
00:02:57
mortgage-backed securitization market to
00:02:59
support the 30-year fixed-rate mortgage.
00:03:03
Third, the need for private capital to
00:03:06
be in a first-loss position
00:03:09
so that the taxpayer is not on the hook,
00:03:11
but in fact private capital,
00:03:13
appropriately so, takes the risk and if
00:03:17
uh
00:03:17
puts
00:03:18
and and evaluates what the risk is and
00:03:21
charges appropriately for the risk in
00:03:23
mortgage rates and in mortgage insurance
00:03:25
rates. This is private markets' role of
00:03:29
setting up incentives and and taking on
00:03:32
losses appropriately.
00:03:34
So, that's a second key. A third key is
00:03:37
that
00:03:38
when there's a catastrophe,
00:03:40
that that's the role for the government
00:03:43
to be there in place for a catastrophic
00:03:47
risk occurrence.
00:03:49
And this consensus that that's the
00:03:51
appropriate role for the government, and
00:03:52
only appropriate role for the government
00:03:54
to step in.
00:03:55
In addition to this,
00:03:57
to
00:03:59
hopefully ensure a more stable market
00:04:02
going forward there's a consensus on the
00:04:04
need for transparency.
00:04:06
A platform for standardization of
00:04:09
mortgage-backed securities mortgage
00:04:12
terms and a public uh le
00:04:15
available
00:04:18
set of
00:04:19
characteristics of the mortgages and the
00:04:22
mortgage-backed securitization. Some
00:04:24
sort of utility that would be able to
00:04:27
verify mortgage terms over time and and
00:04:31
put into place standards for mortgages
00:04:33
and mortgage-backed securitization. And
00:04:35
finally, there is some agreement for
00:04:38
some role for affordable housing.
00:04:41
So, the combination of factors that
00:04:43
there is agreement on is pretty
00:04:45
substantial at this point, but the
00:04:47
implementation of how do we get there is
00:04:50
where there's a great deal of
00:04:51
disagreement.
00:04:56
There are two major proposals that are
00:05:00
uh
00:05:00
that have gotten some support. The first
00:05:03
is the um
00:05:06
uh protecting of the American Taxpayer
00:05:09
and Homeowner Act, which was introduced
00:05:11
by Hensarling in the House in 2013.
00:05:14
Uh and
00:05:16
that
00:05:17
did come out of the House Committee on
00:05:19
Financial Services. It hasn't made it
00:05:21
any further than that.
00:05:23
Uh that
00:05:24
proposal is basically to privatize
00:05:27
Fannie and Freddie entirely, to withdraw
00:05:30
support for Fannie and Freddie 100%.
00:05:32
They would have no no no support,
00:05:35
implicit or explicit.
00:05:37
Uh there would be a common
00:05:39
securitization platform, a utility that
00:05:43
the proposal calls for, and the utility
00:05:45
would support mortgage securitization
00:05:48
standardization. It wouldn't impose
00:05:50
standardization, but it would make
00:05:52
whatever mortgage-backed security
00:05:54
standards were being used,
00:05:57
make them transparent and and and call
00:06:01
for the
00:06:02
mortgage lenders and securitizers to
00:06:04
abide by whatever standards were set
00:06:07
out. But that's as far as the government
00:06:10
or public would go, just set up utility
00:06:13
to oversee the securitization
00:06:16
platform that was
00:06:18
that was put forth. The second proposal,
00:06:21
the second major proposal is by
00:06:23
Johnson-Crapo, and it received support
00:06:25
across the political spectrum. However,
00:06:28
did not receive sufficient support to
00:06:30
come out of the Senate Banking Committee
00:06:32
this past spring in 2014.
00:06:35
But it it did go very far along in terms
00:06:38
of getting consensus among many parties.
00:06:42
There are still obviously points of
00:06:44
major disagreement, which is why it did
00:06:46
not come out of committee. But to first
00:06:48
go to
00:06:49
the points of agreement that were
00:06:50
embodied in this
00:06:52
first of all,
00:06:54
there's a first-loss capital
00:06:56
in private capital in the first-loss
00:06:59
position, very key. Secondly,
00:07:03
some provision for affordable housing.
00:07:05
Third, a platform for trading a single
00:07:09
security that would be
00:07:12
have to be approved by a regulator, to
00:07:16
be very much like the FDIC, with Federal
00:07:19
Mortgage Insurance Corporation, which
00:07:21
would insure mortgages that were then
00:07:24
would be explicitly guaranteed by the
00:07:26
federal government.
00:07:28
MBS that would then trade would be
00:07:32
insured by by aggregators who would have
00:07:34
to be approved also by FMIC. There would
00:07:37
then be competition among the
00:07:39
aggregators to provide for the to
00:07:42
provide mortgage-backed securities at
00:07:44
and
00:07:46
and also the corporations that provided
00:07:49
the the insurance for the
00:07:51
mortgage-backed securities would trade
00:07:54
and there would be private capital up
00:07:55
front. So, this proposal, in fact, if
00:07:58
you went go through the the different
00:08:00
positions of consensus that we discussed
00:08:02
earlier, goes very far along in
00:08:04
embodying those positions of consensus.
00:08:07
And in fact, it was the run-up to the
00:08:10
Johnson-Crapo Act that I think
00:08:12
brought about the sense of okay, this
00:08:14
among this is
00:08:16
this is what we can agree on. So, that's
00:08:18
really where the state of the debate is
00:08:20
at this moment.
00:08:25
In the Johnson-Crapo proposal, the
00:08:28
mortgage-backed securities are insured
00:08:31
explicitly by the federal government
00:08:33
under the regulation of the new entity
00:08:36
Federal Mortgage Insurance Corporation,
00:08:37
similar to the FDIC providing insurance
00:08:39
for demand deposits. And the borrower
00:08:42
ultimately pays
00:08:45
in mortgage rates for an insurance fee,
00:08:48
which is then paid to the federal
00:08:50
government to the entity that's
00:08:53
overseeing the CFMIC, which means of
00:08:55
course that investors are not receiving,
00:08:58
they must pay through the aggregators.
00:09:01
The aggregators must pay up front an
00:09:03
insurance fee to the federal government
00:09:06
for the right to this explicit insurance
00:09:09
in case of catastrophic risk.
00:09:13
And this so what it so the ultimate is
00:09:15
that the mortgage-backed securitized
00:09:16
securities that are trading have no risk
00:09:20
to the investor to the in the
00:09:21
mortgage-backed securities because these
00:09:24
are fully guaranteed explicitly by the
00:09:27
federal government. In order for the uh
00:09:30
the aggregators to receive this
00:09:34
insurance, to get the stamp of approval
00:09:36
by the federal government, the eagle
00:09:38
stamped on their mortgage-backed
00:09:39
securities, to make them
00:09:42
no credit risk, zero default risk to the
00:09:45
investor, they must pay for insurance
00:09:48
from the federal government. And also
00:09:51
they must
00:09:52
abide by standards set up by the FMIC as
00:09:56
well.
00:10:00
Well, there is a one one very large
00:10:03
question. What should be the risk
00:10:05
premium? And of course there's similar
00:10:07
questions over demand deposits. What
00:10:09
should be the risk premium for FDIC?
00:10:12
And whether this risk premium will be
00:10:15
priced accurately over the cycle. These
00:10:18
are all very large questions. And then
00:10:21
there are two other related questions
00:10:22
which are um
00:10:25
well, will there be lenders who are
00:10:27
issuing mortgage-backed securities that
00:10:31
do not have government insurance? And
00:10:33
will those expand over the cycle because
00:10:36
they will be competitively at an
00:10:38
advantage since they do not have to pay
00:10:41
the tax?
00:10:42
And there is nothing in this legislation
00:10:44
which prevents that.
00:10:50
The implementation questions of course
00:10:52
are key. One question of implementation
00:10:55
which was perhaps one of the reasons why
00:10:57
in the end Johnson-Crapo did not get out
00:10:59
of committee is where's the private
00:11:01
capital to support the first loss
00:11:04
position which in the legislation is
00:11:06
required to be 10%. The mortgage-backed
00:11:08
securities market is last estimated $5
00:11:11
trillion. That's $500 billion. Where is
00:11:14
that capital going to come from? Who's
00:11:16
volunteering to put up $500 billion
00:11:20
worth of first loss capital equity to
00:11:23
take the losses in front of the
00:11:25
government. So that's one question. A
00:11:27
second question is what's the guarantee
00:11:30
fee? And of course that will affect the
00:11:33
profitability of the mortgages and the
00:11:36
interest and willingness of private
00:11:37
capital to come to the game. Uh the and
00:11:41
a third question is well, what about all
00:11:43
the other mortgages out there that could
00:11:45
be issued and securitized without a tax?
00:11:48
Will they compete against the mortgages
00:11:51
that do receive the explicit insurance
00:11:54
and will that competition be
00:11:56
pro-cyclical? That is will these
00:11:58
mortgages expand during the boom period
00:12:00
of the cycle? And then during the bust
00:12:03
period they'll be out there uninsured
00:12:05
and potentially causing systemic risk.
00:12:08
So that I think was the one of the most
00:12:11
important questions that was brought to
00:12:13
the structure of Johnson-Crapo. But a
00:12:15
second important question was where's
00:12:18
the role for affordable housing?
00:12:21
Both of those questions get back to an
00:12:23
underlying uh aspect of the proposal
00:12:27
which is this single security
00:12:30
which is a to be um implemented,
00:12:33
regulated, overseen by the federal
00:12:36
government since it would receive the
00:12:37
federal government's explicit backing.
00:12:40
Well,
00:12:41
who is in fact overseeing the single
00:12:43
security? What are the characteristics
00:12:45
of a single security? What is the risk?
00:12:47
What are the terms?
00:12:49
And do these vary among the insurers,
00:12:51
the aggregators that are participating
00:12:54
in this market and that are putting up
00:12:55
the first loss position?
00:12:57
If so,
00:12:59
do we actually have a liquid market for
00:13:02
the mortgage-backed securities that
00:13:05
allow a 30-year fixed-rate mortgage?
00:13:08
Those were all questions which the
00:13:10
legislation as close as it got to being
00:13:14
uh to coming out of the committee at
00:13:16
that point, these questions were raised
00:13:19
in terms of the
00:13:20
pretty much the fundamentals of the of
00:13:24
the proposal which go to the question
00:13:26
would in fact such a uh imp such a such
00:13:30
a structure support the 30-year
00:13:32
fixed-rate mortgage? Would such a
00:13:34
structure be stable over the cycle? And
00:13:37
third, would such a structure support
00:13:40
affordable
00:13:42
financing or more simply financing
00:13:45
broadly available for those who qualify
00:13:48
over the cycle? And those were all
00:13:50
questions which are yet to be answered
00:13:53
and still have to be addressed before a
00:13:55
consensus can emerge.
00:14:01
Well, there's a real range of um
00:14:04
estimates on that and some estimate that
00:14:06
it will be de minimis and some estimate
00:14:08
that it will be several hundred basis
00:14:09
points which of course would be uh
00:14:12
would make these non-competitive against
00:14:15
uh securitizations that did not need to
00:14:17
pay 100-200 basis point tax.
00:14:21
Uh
00:14:21
to my mind the question is how are they
00:14:24
priced over the cycle? So it's not just
00:14:26
a question of a static pricing. It's a
00:14:28
dynamic pricing. And that of course
00:14:30
depends on how risky the overall market
00:14:33
becomes which depends on the entry and
00:14:37
the withdrawal of capital into this
00:14:39
market from other sources. So it's a
00:14:41
very difficult question to answer
00:14:42
without answering that other question of
00:14:45
what's the structure of the
00:14:46
mortgage-backed securitization market
00:14:48
over the cycle.
00:14:53
One I just reform Fannie and Freddie. Uh
00:14:56
question is what do we mean by reform?
00:14:58
There is some consensus on what we might
00:15:01
mean by reform, no portfolio going
00:15:03
forward. And we're moving in that
00:15:05
direction in any case and that's where
00:15:06
the riskiest loans were. Uh a second
00:15:09
part of the uh consensus is that there
00:15:12
should be transparency in the
00:15:14
mortgage-backed securities. There should
00:15:15
be a common securitization platform to
00:15:17
provide transparency so we can track
00:15:20
what loans are in fact being securitized
00:15:22
going forward. And that too is in place.
00:15:25
Uh but then the third component is
00:15:28
really where there is
00:15:30
big questions which is how do we get
00:15:32
private capital into Fannie and Freddie
00:15:35
to take the first loss because there is
00:15:37
consensus that there should be private
00:15:39
capital at risk prior to the taxpayer.
00:15:43
That's a key point where there's major
00:15:45
disagreement and part of this major
00:15:47
disagreement because it
00:15:48
it hinges on the question who owns
00:15:51
Fannie and Freddie? And there are major
00:15:53
lawsuits right now on who owns Fannie
00:15:56
and Freddie that need to be resolved.
00:15:58
And there may also need to be
00:16:00
congressional weighing in on that
00:16:03
question of who owns Fannie and Freddie
00:16:05
because Fannie and Freddie were
00:16:07
originally chartered and still are
00:16:09
chartered
00:16:11
through Congress. These are federal
00:16:13
national charters which are not state
00:16:15
chartered but
00:16:17
chartered by Congress. So we will need
00:16:19
Congress to weigh in on that. However,
00:16:21
there is um
00:16:23
there is movement as we speak in terms
00:16:26
of that third component of bringing at
00:16:29
risk capital, private capital. And both
00:16:31
Fannie and Freddie have instituted a new
00:16:34
uh uh
00:16:35
uh a new derive um a new security uh
00:16:39
just for that purpose to bring private
00:16:41
capital in in front of the taxpayer. Uh
00:16:45
those are trading and they are in fact
00:16:49
um bringing private capital in to to
00:16:53
take first loss
00:16:55
credit risk and to price that credit
00:16:58
risk and to do so transparently. This is
00:17:02
a new development and it's it's um
00:17:05
increasing very rapidly. So in fact
00:17:08
while it seems as though nothing is
00:17:10
happening, much is happening. Uh these
00:17:13
new instruments uh go by the name of
00:17:15
STACR and uh in the case of um
00:17:20
uh of uh Freddie and Connecticut Avenue
00:17:23
securities in case of of um Fannie.
00:17:27
And they are um very large at this point
00:17:30
and they're taking a major share of the
00:17:33
credit risk of both entities.
00:17:35
Uh and of the new issues of of both
00:17:37
entities. So this is a very good
00:17:39
development because in fact what we do
00:17:41
need is we do need not only regulators
00:17:44
to oversee the risk of the mortgage
00:17:46
market, we need a transparent way for
00:17:50
private capital to uh price and reveal
00:17:55
the pricing of the risk of the credit of
00:17:57
the mortgages that are being issued and
00:17:59
either implicitly or explicitly uh being
00:18:02
supported by the federal government.
